Running With the Gold Bulls

The gold bugs were back with a vengeance following Wednesday's announcement that the Fed was not going to scale back quantitative easing, as most had been expecting. At least they gave the appearance of such. Between Wednesday and Thursday, the yellow metal saw the largest gains in the futures market on New York's Comex since 2009, while in London gold for immediate delivery saw its largest jump since June 2012.

Appearances, however, can be deceiving. Herb Greenberg and I were chatting Wednesday just as strength was starting to really emerge in gold. He was long the Gold Miners ETF (GDX) while I was positioning myself into the SPDR Gold Trust (GLD) and Freeport-McMoRan (FCX) intraday. He joked that his position was "not confusing brains with the temporary gold bull." His sentiment mimicked mine precisely. I was already in the middle of writing this column that day, but before I had a chance to publish it the bulls hit the market full steam. Let's take a closer look.

The thing that initially caught my eye in gold on Wednesday was its trend placement. It's no secret that gold has gotten hammered over the past year. It struck new multiyear lows less than three months ago. Throughout July and August, however, it managed a minor recovery. The key feature of this recovery was the way it developed, which was as a two-wave upside correction. The overall momentum of this correction was still slower than the earlier descent and this type of countertrend move is typical of a short-term correction and no guarantee of an actual reversal of the larger trend. The move struck the 38.2% Fibonacci retracement level on the weekly time frame from the continued selloff that began last October and gold was once again moving lower into and throughout the first half of September. Then along came the FOMC announcement.

So, here is the first question that I would like to consider: Did the Fed drive prices higher, or was the market primed for the move already?

I'm going to argue that the direction of the move was already built into the technicals of the gold chart itself. The GLD had fallen 50% off the highs of the "recovery" from July to August, and it did so with a steady trend move on the downside that was similar to each of the two prior upside moves on the daily time frame. This "measured move" lower was also striking support from the congestion that had taken place between the two waves of recovery action. This is typically a strong initial support level on a pullback. In addition, the pace of the selling was slowing early into this week as those support levels hit. This shift in momentum makes it easier for a rally to take off quickly.

Overall, these technical traits left the market primed for bounce on Wednesday regardless of exactly what the announcement would be. Had the Fed gone ahead and tapered, the odds are that the U.S. dollar would have still fallen and gold would have still rallied. The news pundits would have said that the Fed's decision to taper had caused it instead of it being the other way around. In reality, the odds are higher than the market was merely in a holding pattern waiting for the news itself -- it didn't matter exactly what that news was.

This brings me to my next question: Is the post-Fed rally sustainable?

We are already starting to feel signs of a hangover creep in ahead of the weekend. Due to the extreme downside momentum in the first half of the year and the lack of any shift in that momentum as the lows hit in June, the risk of a retest of zone of those lows before the end of the year is very high despite the gains made mid-week. Wednesday's action could very well have been merely the start of what may become a head-and-shoulder continuation on the daily time frame, with congestion following throughout the rest of the month and a break lower into mid-October. It may only retest the zone of June's lows, or panic could flush them out.

The GDX, which tracks the miners, is at risk as well. It will take a few weeks for this scenario to develop, but I'm far from breaking out the champagne glasses to cheer on the emergence of another bull market in gold.

"Temporary gold bull" was precise, indeed.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.